Improving Value

Drug Formulary Design

Drug costs are once again coming under scrutiny as important drivers of healthcare spendingA long-standing method of addressing drug costs has been through formulary benefit design.

A formulary is the list of drugs (medicines) covered fully or in part by a health plan. Formularies typically include both brand name and generic drugs, and are used to manage drug costs.

Tiered Formulary Designs

A tiered formulary divides drugs into groups, based primarily on cost. Insurers have historically used tiered formularies to encourage enrollees to select generic or preferred brand-name drugs instead of higher-cost alternatives. A plan’s formulary might have three, four or even five tiers. If a plan negotiates a lower price on a particular drug, then it can place it in a lower tier and pass the savings on to its members.Traditionally, the lowest-tier drugs are the lowest cost. There is strong evidence that tiered formularies are associated with reduced use of medicines.  Whether tiered formularies impacts quality needs more research.1 Appropriately used, tiered formularies can be an effective cost-control tool, when they send an appropriate cost signal to the consumers concerning the relative value of the drug and when lower cost therapeutically equivalent drugs are available.

Discriminatory Designs

But a recent phenomenon suggests that tiering can be used in other ways. The goal of “adverse tiering” is not to influence enrollees' drug utilization but rather to deter certain people from enrolling in the first place. At least two studies find evidence of adverse tiering.2 New analysis from Avalere Health finds that some exchange plans place all drugs—including generics—used to treat complex diseases, such as HIV, cancer, and multiple sclerosis,on the highest drug formulary cost-sharing tier.3 Specifically, in five of the 20 classes of drugs analyzed, plans placed all drugs in a class on the specialty tier. Moreover, some plans placed all branded drugs from selected classes into a specialty tier  in instances where there was no available generic version. As a result, a consumer would have no alternative but the highest cost sharing tier for drug. The practice was most common for some cancer drugs and drugs used to treat multiple sclerosis. Roughly 30 percent of plans also place all single-source drugs for HIV/AIDS on the specialty tier.

Adverse tiering is problematic for two reasons. First, it puts substantial and potentially unexpected financial strain on people with chronic conditions. Second, these tiering practices will most likely lead to adverse selection over time, with sicker people clustering in plans that don't use adverse tiering for their medical conditions.

Avoiding Underutlization

In the case of medications with preventive benefits, that is that prevent future illnesses and complications, different thinking may be different. Here, patients do not always understand the long-term benefits of continued use. In this case, lower cost sharing may be appropriate (regardless of the original cost of drug).4

What are the rules for Drug Formularies?

Under the ACA, as part of the Essential Health Benefits package, health plans must include choices within commonly prescribed drug categories and classes in their formularies but they have tremendous flexibility with respect to how enrollee cost-sharing is established. HHS will require healthcare plans to use pharmacy and therapeutics (P&T) committees to ensure that their formulary lists sufficiently cover prescription drugs, while keeping the current drug count standard and classification system, according to CMS' final rule on 2016 benefit and payment parameters.  The rule mandates that such information be presented in a way that is easily accessible and understandable to the public online, as well as machine-readable so that third parties can come up with applications and tools that let consumers explore and compare their options.

Some states are considering more prescriptive requirements around cost-sharing in drug formularies. Colorado issued a such a bulletin.

Perverse Incentives for Pharmacy Benefits Managers

Pharmacy Benefits Managers (PBMs) are supposed to negotiate lower prices for their clients, employers and other plans sponsors. But drug manufacturer rebates to PBMs can undermine the PBM role as an intermediary working on behalf of clients to negotiate lower costs. PBMs often obscure the actual net costs of the drugs to an employer. Lucrative rebate deals may encourage the placement of more expensive drugs onto a formulary. In some cases, it is possible that, unbeknownst to the employer, a PBM pockets the rebate, while sticking the full cost for the more expensive choice to the employer. Rebates may also skew PBM formulary placement decisions, that should be based on the best evidence available, not on perverse financial incentives from drug manufacturer.5


1. Steve Morgan, Gillian Hanley, and Devon Greyson, "Comparison Of Tiered Formularies and Reference Pricing Policies: A Systematic Review, Open Medicine.

2.  Jacobs, Douglas B., and Benjamin D. Sommers, "Using Drugs to Discriminate—Adverse Selection in the Insurance Marketplace," New England Journal of Medicine (Jan. 29, 2015). 


4. Avi Dor and William Encinosa argue in Does Cost Sharing Affect Compliance? The Case of Prescription Drugs (NBER Working Paper No. 10738.)

5. See: